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China Aviation Oil (Singapore) Initiation of Coverage China Aviation Oil (Singapore) Initiation of coverage Fuelling growing aviation demand Aviation services 27 February 2017 As the sole licensed importer and supplier of jet fuel to China’s civil aviation industry, China Aviation Oil (Singapore) Corporation (CAO) is a Price S$1.53 direct play on the rapidly rising demand for air travel in China, augmented Market cap S$1,316m by both international and product expansion. While a healthy dividend S$1.4064/US$ income from a joint venture at Shanghai’s rapidly expanding Pudong Net cash (US$m) at 31 December 2016 187 Airport provides the bulk of earnings, the growing trading and supply of oil Shares in issue 860.2m is supportive of our 14% EPS CAGR over the next two years. Our cash and peer-based fair value of US$1.45 (S$2.04) suggests potential for investors. Free float 29% Code G92.SI Revenue PBT* EPS* DPS P/E Yield Primary exchange SGX Year end (US$m) (US$m) (c) (c) (x) (%) Secondary exchange N/A 12/15 8,987 63.0 7.3 2.1 14.9 1.9 12/16 11,703 90.3 10.4 3.2 10.5 2.9 Share price performance 12/17e 13,232 103.3 11.9 3.6 9.2 3.2 12/18e 14,918 116.9 13.5 4.0 8.1 3.3 Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. Chinese aviation growing rapidly Chinese air travel grew at 15% in 2015, with international flights from People’s Republic of China (PRC) growing at 32%. China is expected to lead future global aviation traffic growth, with a committed airport build strategy and increasing business and leisure demand. As the sole supplier of imported jet fuel into PRC, % 1m 3m 12m CAO is exposed primarily to international traffic growth due to the restrictions on Abs 1.3 11.3 146.0 bonded fuel use. For CAO, stability is provided by the fixed price per barrel that it Rel (local) (1.1) 1.6 106.7 receives on this core supply. However, its associate Shanghai Pudong International Airport (SPIA) owns and operates the entire refuelling infrastructure at the airport. 52-week high/low S$1.56 S$0.62 Despite only owning a 33% share, this is the largest contributor to CAO’s Business description profitability and cash flow (through dividends), accounting for c 62% of operating China Aviation Oil (Singapore) Corporation (CAO) profit in FY16 and most of cash flow. With the airport currently being expanded, the is the largest physical jet fuel supplier and trader in demand for jet fuel should continue to grow rapidly which, combined with the Asia. It holds the sole import licence for bonded jet exclusive import licence to the PRC, provides a firm foundation for investors. fuel into China, and has nascent businesses in the US and Europe. Of its five associates, the most important is SPIA, which supplies all jet fuel to Strategy to expand capability and regionally Shanghai Pudong Airport. CAO is the largest physical jet fuel supplier and trader in Asia. CAO management is Next events augmenting the growth afforded by the Chinese Aviation market by extending its reach geographically, and trading in a wider range of products. In FY10, 80% of Q1 results 19 April 2017 revenues came from China, whereas in FY15 that figure had fallen to 52%. It now Analysts supplies jet fuel to more than 40 international airports in Asia, EMEA, North Andy Chambers +44 (0)20 3681 2525 America and Europe. It continues to add assets to its supply infrastructure including Alexandra West +44 (0)20 3077 5700 storage. The ambition of Vision 2020 is to become a reputable global supplier of [email protected] aviation fuels and synergistic transport fuels, including new clean alternative fuels. Edison profile page Growth prospects justify a re-rating China Aviation Oil (Singapore) CAO is trading on 9.2x our FY17e EPS, at a 32% discount to its closest peer World is a research client of Edison Fuel Services. While some disparity can be justified by global scale, the exposure Investment Research Limited to Chinese growth warrants a closure of CAO’s relative rating. Investment summary Company description: Largest jet fuel supplier in Asia-Pacific CAO is the largest physical jet fuel trader in the Asia-Pacific region and the sole supplier of imported jet fuel to the civil aviation industry of China. The company relisted a decade ago and in that time it has internationalised its business; 52.5% of its revenues came from China in 2015, compared to 80% in 2010. It is the second largest provider of fuel to LA International Airport (LAX) after Chevron, and its growth strategy is to expand into other geographies. The group also trades other oil products and owns investments in oil-related businesses such as storage, pipelines and airport refuelling facilities. The Chinese government owns a 51% stake through China National Aviation Fuel Group Corporation (CNAF) and BP owns 20%, leaving 29% in free float. Strategic direction is encompassed in long-term plans. The current Vision 2020 was launched in 2013 and provides the basis for CAO’s expansive strategy. The company is seeking to become one of the largest transportation fuel providers in the world, leveraging its strong position in Asian jet fuel supply to continue to expand both its product offering and territories served. It is already a global player, has expanded into other transportation fuels, has an integrated supply chain and developed very strong trading and risk management skills. Valuation: Securing progressive growth is key CAO‘s closest peer comparator is World Fuel Services, which currently trades at a 48% premium to CAO. In our opinion, this is unwarranted given its unique exposure to the fast growing Chinese aviation market. We value the core CAO operations using a DCF given the relative stability offered by being a physical jet fuel supplier as well as trader. Paper trading of oil contracts is limited to 10% of total trade volume, with 90% backed by physical contracts substantially de-risking the activity. The cost plus per barrel nature of the sole source import supply contract to China provides further stability as well as a gross margin premium return compared to normal trading activity. Using our calculated WACC of 10.4% implies a core CAO valuation of US$0.80/share (S$1.12). To value the substantial associates contribution appropriately, we use a simple P/E combined with two DCF valuations of the dividends. This provides a composite value of US$0.64 (S$0.90) per share. Our total DCF-based fair value for CAO is thus US$1.44 (S$2.02) per share. Including higher peer group multiples increases the fair value to US$1.45/share (S$2.04). Financials: Balance sheet strength facilitates strategy CAO is a well-capitalised and cash-generative company. The stability afforded by the associates’ large contributions also acts as a buffer against undue oil market volatility. With a positive net cash inflow in 2016, CAO currently has cash balances of c US$187m. This supports the expansionary strategy based on organic growth and M&A. As CAO grows its international standing, augmenting the rapid growth likely to be driven by Chinese air transport, returns should be enhanced further. Management’s commitment to a 30% payout ratio from 2015, as opposed to the fixed dividend previously, is increasing shareholder returns, with a 50% dividend rise in FY16. This is especially true if the company can secure resilient and progressive growth, as per its Vision 2020 strategy. Sensitivities: Risk management for volatile markets Given price fluctuations for oil products, the volatile nature of fuel supply markets and the inherent risks in trading activities, albeit well managed utilising sophisticated strategies, the consistent achievement of growth expectations in any territory is challenging. However, the ability of a shift in government policies to interfere and disrupt markets is very real. China Aviation Oil (Singapore) | 27 February 2017 2 CAO – the largest trader of jet fuel in Asia China Aviation Oil (Singapore) Corporation (CAO) was incorporated on 26 May 1993 and was floated on the main board of the Singapore Stock Exchange in 2001. Its shares were suspended from trading in 2004 and relisted in 2006 after a significant restructuring. The company has two major shareholders: China National Aviation Fuel Group Corporation (CNAF) owns 51% of the company and the oil major BP owns just over 20% (see Exhibit 1). CNAF is state owned and is the largest provider of aviation transportation logistics services in China. CAO’s chairman is always a member of the CNAF board. Exhibit 1: China Aviation Oil (Singapore) Corporation (CAO) group structure Owners BP (20.17%) CNAF (51.31%) Public (28.52%) Parent Company CAO Trading Companies CAOHK NAFCO CAOE CAOT Pte Ltd Associates CNAFHK (39%) SPIA (33%) TSN-PEKCL (49%) Xinyuan (39%) OKYC (26%) Source: CAO Annual Report 2015, Edison Investment Research CAO is the largest physical trader of jet fuel in Asia and has the sole import licence for bonded jet fuel into China. It has two divisions, as shown in Exhibit 2: Middle Distillates and Other Oil Products. Exhibit 2: China Aviation Oil (Singapore) Corporation (CAO) divisional structure CAO Middle Distillates Other Oil Products Associates (78% FY15 revenue) (22% FY15 revenue) (67% FY15 PBT) Jet Fuel Supply (China) Gas oil CNAF HK (39%) Jet Fuel Supply Fuel oil (International) SPIA (33%) Aviation Marketing Avgas TSN-PEKCL (49%) OKYC (26%) Xinyuan (39%) Source: CAO Annual Report 2015, Edison Investment Research Middle Distillates generated 78% of the group’s revenue in FY15.
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